RIO DE JANEIRO, BRAZIL – The Central Bank Monetary Policy Committee (COPOM) has held the SELIC rate at 2% a year for four meetings so far. But should it depend on the expectations of a significant part of the financial market, the situation is likely to change in the first half of this year, with the beginning of a process of interest rate hikes to contain inflation.
The SELIC interest rate is the monetary policy interest rate, i.e, the key tool used by the Central Bank of Brazil in the implementation of monetary policy.
The first indication was given with the removal of the expression “forward guidance”, which worked as a “technical barrier” to interest rate hikes, in the press release issued after the last meeting.
According to the January meeting minutes, some of the COPOM members were already considering the need to start raising the SELIC, but, given the uncertainties, the decision was made to wait for further information on the economic scenario and the coronavirus pandemic.
Last Thursday, February 11th, Central Bank (BC) president Roberto Campos Neto said that this intention with respect to changes in the SELIC referred only to March.
Campos stressed that the fact that the Central Bank is reporting a divergence should not be construed as an indication of its monetary policy, thereby undermining the market’s perception of an interest rate hike at the next COPOM meeting next month.
The latest BC Focus report, which compiles the weekly market expectations (banks, asset managers, non-financial companies, consulting firms, class associations, academia, among others), pointed to the maintenance of the SELIC at the March COPOM meeting, but with an increase toward the 3.50% level at the end of the year and 5.00% in December 2022.
The bulletin also shows an inflation perspective of 3.60% registered by the Broad National Consumer Price Index (IPCA) in 2021 and 3.49% in 2022.
Given this scenario, few managers have taken a position in favor of keeping interest rates at their current level. One of the dissenting voices comes from the Persevera team, led by Guilherme Abbud, one of its founders.
Be brave, Central Bank
In a letter to investors in January, Persevera said that fears that the “dragon of inflation” will resurface are understandable, given the magnitude and speed of the fiscal and monetary stimulus implemented in 2020, higher than in the global financial crisis.
However, the manager advocates looking in the opposite direction, assessing that the world faces “uncomfortably inflationary” structural issues.
“The market will be disappointed with the activity, will be surprised with low inflation and see that the exchange rate will only produce an inflationary spike,” says Abbud, emphasizing that he expects a 3% rise in the IPCA this year, a 2.5% growth in GDP and a dollar at R$4.50 in December. “We think that the SELIC is not out of place for the current reality, it should even drop more.”
According to the director, the bulk of the price hike has already occurred, amid the emergency aid, the rise in commodities and the strong exchange rate devaluation. He draws attention to the high level of indebtedness in the country and an unemployment rate also high, which supports the prospect that the rebound will take a few years.
“If the Central Bank has cold blood, patience, it will be clear in a few months that Brazilian activity is strongly decelerating and that higher inflation was a spike,” says Abbud.
The concern is that the Central Bank may be allowing two factors to compete with the perception of an inflation under control. The first would be the “overall feeling” that interest rates have already dropped too much, as if the current level were incompatible with the reality of the Brazilian economy.
And the second question concerns the perception that the monetary authority would be able to normalize exchange with higher interest rates, which is challenged by Persevera.
Foreign investors with significant clout in the market, who historically sought the carry trade – a strategy that involves selling the currency of a lower-interest country, considered safer, and buying currency from another nation with higher interest rates – are not likely to come back anytime soon, Abbud points out.
“Brazil expelled the money that only came through the carry trade, and there is no point in raising the SELIC from 2% to 4%, the carry trader won’t come back. Interest rate differentials would have to rise above 10% for that to return.”
The director argues that the Central Bank should wait for at least two meetings to observe the indicators before making a decision to change interest rates. And if it doesn’t raise the SELIC by May, Abbud believes it won’t raise it any more this year.
Given this scenario, Persevera advocates a combination of stock market and fixed interest securities with maturities of at most three years in the portfolio.
Preparing for the rise
With different views from Persevera, some managers see reasons for the SELIC to be substantially increased in 2021. This is the case of Occam Brasil, which expects the basic interest rate to close December at 5% per annum, after six consecutive highs.
According to Pedro Dreux, partner and manager of Occam Brasil, after the exclusion of forward guidance, the Central Bank is preparing the ground for a rise in the SELIC that should occur as of March or in May, depending on the data released in the period.
Although in January inflation registered the lowest rate since August, with a 0.25% rise in the IPCA, Dreux expects prices to once again surprise negatively this year, closing 2021 with 4.10% inflation, again above the target set by the government, of 3.75%. In 2020, inflation measured by the IPCA stood at 4.52%.
“The sooner the Central Bank acts, the better. The later, the higher the adjustment will have to be,” assesses Occam’s manager.
Window of opportunity
In addition to inflation, among the main factors that contribute to Occam’s projection for the SELIC rising higher than expected by the financial market, are the high global liquidity environment and the pace of world economic rebound, particularly in China and the United States, that tend to increase the demand for commodities.
Dreux believes that the pickup in activity also implies a more bullish scenario for global interest rates, with nominal rates in the U.S. already steep since the second half of 2020.
“The Central Bank is finding a favorable window in the international environment and should seize this to start the process of normalizing interest rates here,” he assesses.
According to Occam’s manager, should the monetary authority need to raise the SELIC faster given the fiscal fragility and excessive debt, and should this occur at a time when the appetite for risk is negative, the process may become “disorderly”.
Allocation
In Brazil, Occam holds a position that profits from the rise in future interest rate contracts and in implicit inflation (expectation of future price variation). Occam expects a 4.5% drop in Gross Domestic Product (GDP) in 2020, followed by a shy 3% growth in Brazilian activity in 2021.
On the exchange rate, Dreux says he expects the real to depreciate against the dollar, although the investment house now holds a neutral position on the American currency.
With activity rebound taking over the scenario in 2021, the manager says he likes cyclical issues in the global stock markets, with exposure to commodities, in addition to maintaining a relevant position in technology companies.
Source: InfoMoney